For example, if you wanted to go long 1 standard lot of USD/JPY, you would be buying $100,000 by selling an equivalent amount in Japanese Yen (depending on the ask price).

Currency Trading Basics #8 – Margin & Leverage

In the previous example, you might be wondering, “Do I really have to purchase $100,000 for a standard lot, or even $1000 for a micro lot? That’s a lot of money!”

Well, thanks to a concept called “leverage”, you don’t need a lot of capital to trade Forex.

When you open a Forex trading account online, your Forex broker will allow you to leverage the margin in your account.

The amount of leverage depends on the broker, but it can be as high as 500:1 at some brokers.

500:1 leverage means that you have 500 times the purchasing power for every $1 of margin. So $1000 allows you to purchase $500,000 worth of currency.

Be very careful with leverage. It magnifies profits, but it also magnifies losses. Ideally, you should trade with leverage no higher than 200:1.

Risk management, particularly proper position sizing, is just as important as trading strategy.

Don’t get greedy and risk too much capital on any one trade.

If you do, a losing trade has the potential of becoming a catastrophic loss that can wipe out a significant chunk of your account balance.

Currency Trading Basics #9 – Currency Pair Pricing

Prices for Forex currency pairs are always quoted in the denomination of the counter currency. It’s the “exchange rate”, the amount of counter currency equal to 1 unit of base currency.

As such, your profit or loss is always in the denomination of the counter currency.

There are actually 2 prices quoted for a currency pair…the bid rate and the ask price.

The bid rate is what you would sell the base currency for and the ask price is what you would buy the base currency for.

For example, let’s say the current price quotation for the USD/JPY is:

Bid 89.31 x Ask 89.33

This means that it would cost ¥89.33 to buy $1. At the same time, if you were to sell $1, you would receive ¥89.31.

Currency Trading Basics #10 – The Spread

The difference between the bid and ask price is called the “spread”.

As a trader, it would be in your best interest to find a good Forex broker who offered low spreads.

You could also trade during more active times of the day for your currency pair, when spreads tend to tighten due to the higher liquidity.

The lower the spread, the lower the number of pips to break even, and the higher your chances of making a profit.

A “pip” is the smallest price increment a currency can make. It’s how you measure your profit or loss.

As you can see in our previous example, as soon as you go long or short the USD/JPY pair, you’re already in the hole by 2 pips (the spread).

89.33 Ask minus 89.31 Bid = 2 pip spread

If you’re long, the currency pair would have to move up 2 pips in order to break even…

…a move higher than 2 pips and you’re in profit!

Currency Trading Basics #11 – Rollover Interest

When you trade Forex, your open position will consist of the currencies of two different countries.

Don’t forget that currency is money, and money itself has a price…interest.

The difference in interest rates between the two currencies in your open position is known as the “interest rate differential”.

If you’re holding an open position at 5 p.m. Eastern Time, you will either pay or earn the interest rate differential.

It depends on whether you’re holding the base currency long or short, and whether that base currency has a higher or lower interest rate than its counter currency.

The table below will help you determine whether you pay interest…

…or get paid interest. (Cha-ching!)

Currency Trading Basics Rollover Interest

If you’re holding a position that earns interest, it would be like having an “automoney machine” generating automatic cash flow for you.

Of course, the amount of interest you earn would depend on the size of your position.

Currency Trading Basics #12 – The Carry Trade

There is actually a long-term strategy known as the “carry trade” that takes advantage of this interest-rate differential. It could be worth looking into as a viable trading strategy.

However, if your trading strategy does not involve the carry trade, then don’t let rollover interest affect your trading decisions. The amount of interest earned or paid is usually insignificant relative to the amount of profits you’re going for.